Nonprofit organizations may be exempt from paying federal income taxes in the US, if they meet a certain set of criteria. Non-taxable nonprofits are attractive to donors and sponsors looking to reduce their personal tax liability, meaning nonprofits benefit from being able to raise funds easier when they’re tax exempt.
Not every nonprofit is tax exempt, so it’s important to understand the rules and regulations surrounding nonprofit tax returns and understand how your organization fits into the picture.
What is a non-profit organization?
A nonprofit is an organization that doesn’t operate for profit or personal gain, but rather exists to serve public or private interest. Nonprofits cannot issue stock, and any profits they generate cannot be distributed to shareholders and owners. Profits must be used towards activities that serve the purpose of the nonprofit.
While you might think of charities when you hear the term nonprofits, in the US there are 27 different types of nonprofit organization, each with their own sets of rules and conditions.
Types of nonprofit include social advocacy groups, charities, social and recreational clubs, foundations, welfare associations, fraternal societies, cemeteries, and more. Each of these nonprofit types has its own Internal Revenue Code (IRC) classification (e.g. 501(c)(4) for social advocacy groups) that defines the rules it must abide by.
Nonprofit tax exemption
Any nonprofit organization with 501(c) classification is exempt from paying federal income tax. 501(c) is the subsection of the Internal Revenue Code that defines these tax exemptions and who is eligible for them.
501(c) classification means that an organization is exempt from most individual and corporate taxes, including federal income tax. There are, however, some payments that a nonprofit organization may still have to make. Nonprofits that hire employees will still need to pay employee taxes, like Medicare, Social Security, and Unemployment. Furthermore, any nonprofit that earns income on activities not directly related to their purpose will need to pay income taxes for those earnings.
In addition to federal income taxes, 501(c) classified nonprofit organizations are also exempt from sales and property tax.
Nonprofits that aren’t tax exempt organizations
Most, but not all nonprofit organizations have 501(c) status. An example of a nonprofit that doesn’t fall under section 501(c) is religious associations that share a common treasury. These are 501(d) groups, meaning donations to these organizations are not tax exempt. Churches and other religious organizations do still qualify under section 501(c)(3).
Most nonprofits with a political agenda, who publicly show support for or donate to a political campaign, do not qualify for tax exemptions.
Nonprofit tax returns
Nonprofit tax-exempt organizations will be required to file a specific IRS tax form depending on their income. This will be either form 990, form 990EZ, or form 990-N. These forms outline the purpose and activities of the business, and details all revenue, expenses, assets, and liabilities.
Accurately completing and submitting these accounting forms is absolutely vital for any nonprofit looking to maintain their tax-exempt status.
The information contained in these forms is made available to the public to offer complete transparency and ensure nonprofit organizations aren’t hiding any earnings.
Applying for tax exemption status
Most nonprofit organizations aren’t automatically tax exempt – they must apply for recognition of exemption with the Internal Revenue Service. Applications under 501(c)(3) – corporations, funds or foundations that operate for charitable, scientific, educational, literary or religious purposes – must be made within 27 months of the organization’s creation. Applying for nonprofit tax-exempt status typically comes with a user fee.
Section 501(c)(3) organizations can apply using Forms 1023, 1023-EZ, and SS-4. Other nonprofits can apply with forms 1024, 1024-A, SS-4, or 8718.
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